3 I. Background Ethiopia 1.1 Overview of the Rural SectorPopulation in 2008 = about 80 million.GDP per Capita = USD 180 in 2006.One of the poorest countries of the world.Poverty is endemic to the country the poor makes insufficient money to cover daily meal, health, education and other services.Poverty reduction is the central element of the Governments’ development agenda and hence, rural financial policies, goals and objectives focus on targeting primarily the poorest and disadvantaged rural households.

4 The Rural SectorThe rural sector involves all villages and rural towns where themajority of the population lives.About 80% of the country's population lives in rural areas and themajority of the rural population is engaged in agriculturalproduction.Apart from agriculture, sizeable portion of the rural population isengaged in non-farm activities that have gradually increasing inrecent years.In Ethiopia, the rural sector plays a decisive role in the growthand development of the national economy. Agriculture is thedominant economic activity of the economy that accounts fornearly 50% of the GDP.

5 Characteristics of the Rural SectorAgricultural activities are the main stayLow level of productivityConstitutes an emerging rural non-farm activitiesHigh level of povertyUnderdeveloped infrastructurePoor entrepreneurial developmentNatural resource degradationShortage of capital & poor saving habit leading toseasonal income fluctuationsWeak local government institutions

6 The level of development of the rural economy in most of development countries like Ethiopia has got a direct influence on the overall national economy.Thus, efforts and resources allocated in these countries to promote accelerated economic development largely focus on the transformation and modernization of the rural sector.A prominent obstacle to rural development is the problem of mobilization of resources, which is crucial in achieving rapid economic growth of the rural economy.

7 The initial step in resource mobilization for development purposes is the mobilization of financial resources that leads to capital formationSince the rural economy represents a substantial proportion of the country's human and natural resources, large amount of capital is needed to help transform and modernize this sector.Rural financial institutions, i.e. microfinance institutions (MFIs) are, thus, relevant important financial institutions which are designed and expected to encourage and mobilize savings and also channel such savings into income generating activities in the rural areas.

8 1.2 The Financial SectorAs in the most developing countries , the financial system of Ethiopia is characterized by the co-existence and operation side by side of a formal sector and an informal financial sector.The informal financial market, for the most part, is outside the framework of national accounts and statistics. However, the majority of the rural population is considered to be the direct beneficiary of the informal credit sources.Formal credit sources have got institutional form and they are organized based upon the economic policy of the country.

9 Formal sources of rural credit in Ethiopia are:the banking systemMFIsSACCOs/RUSACCOs2.2 Importance of Rural FinanceRural finance covers provision of credit, savings mobilization, activities and providing other essential financial services such as money transfer.Rural finance is an effective tool of poverty reduction and rural development. Its impact is fully observed only when conducive policies are in place, markets are functional and non-financial services are available.

10 Rural credits are considered as very important means of increasing investment capacity of farmers for increased employment and food production thereby alleviating poverty, famine and hunger.

11 2.TRENDS OF Rural/Microfinance Development in Ethiopia 2.1 Development &RoleIn Ethiopia, formal rural credit service has been subject to government policy intervention during the last two-three decades.DBE was the main source of agricultural credits.CBE has been providing input credit since the 1986 NBE’s Rural Credit Policy Directive that permitted CBE to participate in the rural credit market.

12 As part of NGO relief and development efforts as well as to address the growing demand for credits in the rural sector the microfinance credit scheme was launched in early 1990’s.A proclamation for licensing and supervision of microfinance business was issued by NBE in Currently, more than 27 MFIs are registered by NBE.One of the most important innovations in development finance in recent years has been the emergence of microfinance.

15 Lending MethodologiesGroup solidarity loans – main method, usually small loans, members cross-guarantee each otherIndividual lending – larger size, loans to small business graduated from MFIs loans to employeeMembers owned & managed lending – SACCOs/RUSACCOsMicrofinance in Ethiopia is an infant Industry, but the sector is tremendously growing in terms of number of MFIs, both geographical and client outreach, loan outstanding, saving mobilization, capital, assets, etc.

18 Available evidences from various studies and reports show that microfinance services in Ethiopia will:Reduce poverty through increasing income, smooth consumption flows, expand asset base, and improved living conditionsImprove health care & nutritionWomen’s empowermentImprove children's education, etc.The ability to borrow, save and earn income reduces economic vulnerability particularly for women and their household.Successful MFIs have manifested that the poor are bankable and banking with the poor can be profitable and sustainable.MFIs have proved that it is possible to achieve both objectives of reaching the poor as well as be financially sustainable

20 LessonsPoor women and men have shown that they are bankable and responsive to MFI financial services.MFIs need to be cost effective so as to reliably provide adequately provide financial services and increase their outreach.Simplification of loan process and reduction of loan disbursement lead time will make clients confident of being funded on time.Linkage of MFIs with the banking system requires timely action.Rural households need to be linked to markets as well as rural credit and other support systems. The interdependence of credit and product/input markets is very important and would remain critical for rural development.Support in areas of capacity building, technical assistance, marketing information is critical for the rapid growth of the microfinance industry.Collection of reliable client information will help careful screeninig & timely loan disbursement.

21 …Continued lessonsClose monitoring of loan performance results in high on-timecollection rates and reduces loan losses.Introduction of regulations of new instruments like warehousereceipt (voucher) system & contract farming/out growerscheme and assurance to clients based on the socio-economic setting of the country would have considerablecontribution.Training of clients need to be strengthened.Beneficiaries’ participation should be pursued at design andimplementationThere is considerable and sharply growing unmet demand forcreditCredit services should be demand driven.Provision of repeat loans with a gradual increase of the loan sizefollowing good loan repayment.

22 3. Factors that Contrbuted to MFIs’ Rapid GrowthThe Ethiopian MF industry has witnessed a remarkable growth in the past years. Both external as well as internal factors contributed to this growth:External factorsGovernment supporti. Commitment of the Federal Governmentii. Regulatory and supervisory frameworkiii. Institutional capacity building supportiv. Support in linking MFIs & commercial banksv. Design & implementation of donor financed special support programs like RUFIP, etcDonor supportGrant fund for capacity buildingTechnical assistance

23 Internal FactorsMost MFIs have vision, mission and explicit objective that make poverty reduction part of their organizational culture.At the same time their operation is geared towards cost effective way of reaching the poor. Operational self-sufficiency of most MFIs is higher indicating that their revenues would cover their operating costs, costs of loan losses and raising their capital.The existence of the MF Network (AEMFI), from which they get multi-faceted support like training, technical assistance, etc.

25 4. Challenges of Rural FinanceShortage of loanable fund to address the growing demandLimited capacity for smaller MFIs in expanding outreach to new areasWeak linkage between MFIs & banksPoor saving culture – (like depositing in the morning and withdrawing in the afternoon)Underdeveloped credit culture - belief that credit should be donationGrowing drop out rate due to poor group formation and preparationHigh illiteracy lends making training & awareness very costlyLack of adequate information for loan processingAbsence of bank branch network and hence high travel costInvolvement in several credit programs by clients leading to the case of borrowing from X MFI to repay Y MFI.HIV/AIDS & other related problems

26 Contnued…..Challenges of Rural FinanceThe major challenges of rural/microfinance institutions can be summedto the concept of “Critical Microfinance Triangle” [Zeller andMayer(2002)], which requires the need for any MFI to managesimultaneously the problem of outreach, financial sustainability andimpact as shown below:

27 Outreach – reaching the poor in terms of both number and depth …Continued Challenges of Rural FinanceOutreach – reaching the poor in terms of both number and depthFinancial sustainability – meeting operating and financial costs over the long-termImpact – having observable effect upon clients’ quality of lifeBased on this concept, MFIs should be able to:Choose their target clients – ensure large number of target clients are reached using cost-effective meansDevelop range of products that could meet clients’ needsSet simple and standard loan proceduresReduce transaction and supervision costs

28 Best Practices/InnovationsThe following key innovative approaches are effective tools for addressing rural finance challenges:Firm vision/mission to reach the poor – increasing outreach with the ultimate goal of reaching large number of clients and poverty reductionSimple and innovative products, i.e. development of demand driven financial productsCost effective MFI for attaining operational & financial sustainability – control over administrative expenses and effective use of resources

30 6.ConclusionThe building cornerstones for achieving MFIs’ financial successare:efficiency & effectiveness of processesDevelopment of quality servicesSupport for innovation in operation and servicesResponsiveness to client needsThe innovations compliment each other. Using acombination/ integration of approaches in providingfinancial services to the rural households could be a betteralternative of doing things effectively.